China's Weakening Property Sentiment To Put Pressure On Economy

Sentiment within the Chinese residential property market is souring amid softening home sales and failed land auctions, and we therefore expect the strong real estate fixed asset investment (FAI) growth to weaken over the coming quarters.

Declining property FAI growth is likely to add another layer of pressure to the Chinese economy amid an increasingly challenging external environment brought about by an escalation in US-China trade tensions, informing our forecast for real GDP growth to weaken to 6.4% in 2019, from 6.7% in 2018.

Real estate FAI has been a bright spot for the Chinese economy over the first three quarters of 2018, but in our view, the best is likely behind us as the residential property market will likely soften over the coming quarters. This will add another layer of pressure to an economy that is already facing an increasingly difficult external environment due to rising US-China trade tensions. We are therefore maintaining our forecast for real GDP growth to slow to 6.4% in 2019, from 6.7% in 2018.​​​​

According to the National Bureau of Statistics (NBS), real estate FAI growth came in at 9.9% y-o-y for the January-September period, which was higher than 5.4% y-o-y for the headline rate. However, on a monthly basis, property investment growth cooled for the second straight month to 8.9% y-o-y in September, from the peak of 13.2% y-o-y in July 2018. We believe that this strong pace of investment is likely unsustainable in light of weakening property sales volume, which is set to worsen as Chinese policymakers aim to tighten policies to rein in the increase in house prices while existing curbs continue to bite, amid rising mortgage rates.

Nation-wide property sales volume declined by 3.6% y-o-y in September, the second time sales contracted since April 2018, and we expect the ongoing downtrend to remain intact. Growth of sales in Tier 3 and 4 cities fell by 0.7% y-o-y in September, from 3.9% y-o-y in the previous month, and we expect it to continue to be dragged by the government’s lower compensation for tenants in shanty towns for purchasing new residential apartments (see ‘Surging Chinese House Prices To Prompt Tighter Restrictions’, August 20).

Weakening Demand In Tier 2 And Lower Cities

China – Property Sales (In Gross Floor Area Sold), % chg y-o-y

Source: Wind, Bloomberg, Fitch Solutions

Additionally, Xinhua News published a report on October 29, stating that China will not ease property measures even with a slowing economy, as the authorities look to ensure the healthy development of the market, which was clearly communicated during the Communist Party of China’s 25-member Politburo meeting on July 31. It was also reported by South China Morning Post in the middle of October that the authorities are considering banning presales of homes, and discussions are underway in provinces such as Guangdong, Hubei, Jiangsu, and Sichuan. Given that presales account for more than 80% of total home sales volume, the implementation of this strict restriction would result in an even greater contraction in home sales.

Falling Share Of Domestic Loans Reflects Cautious Banks

China – Sources Of Funding For Real Estate Development, % Of Total

Source: Wind, Fitch Solutions

Funding To Come Under Pressure To The Detriment Of Investment

In an environment where housing demand is likely to come under pressure, we expect Chinese property developers to also face rising funding pressures, which will weigh on their ability to increase their land reserves and continue investing at a rapid pace. According to Wind, other sources of funding for developers, which mainly include cash, advance payments, and mortgage payments, accounted for 51.9% of total. This would exacerbate the reduced credit extended by commercial banks to developers (accounting for about 15% of total) on concerns about a housing bubble. Domestic loans for property development contracted by 5.1% y-o-y for the first nine months of 2018, compared with an increase of 20.2% y-o-y in the same period in 2017. Indeed, it was reported that the Chairman of major Chinese property developer China Vanke Group Yu Liang stated in a meeting in September that ‘survival’ is the ultimate goal for the firm’s three-year strategic plan, and given his concern about cash collection, the company should invest more strategically going forward.

Additionally, there are signs that the land market is already cooling amid failed land auctions, and this trend is set to continue over the coming months. In the first seven months of 2018, the number of failed land auctions more than doubled to 796 from a year earlier, according to Centaline Property Agency. At the same time, the growth in the 100-cities land auction price (on a 12-month moving average basis) moderated to 14.8% y-o-y in September from the peak of 36.1% y-o-y in October 2017.

Growth in the floor area of newly started real estate projects and those under construction respectively retreated from the highs of 31.8% y-o-y and 26.6% y-o-y in August to 20.1% y-o-y and 20.3% y-o-y in September, and in our view, it is likely to come under pressure as developers find it more difficult to continue building at a strong pace amid a decline in home sales.

We believe that weakening home sales will result in negative spill-over effects to real estate-related retail sales over the coming months as demand for such products is likely to worsen. Growth of retail sales for household appliances, furniture, as well as building and decoration materials moderated to 8.4% y-o-y for the January-September 2018 period, from 11.1% y-o-y in the same period in 2017, and this will also likely be compounded by weakness in disposable income brought about by job losses due to rising US-China trade tensions.

Weakening Home Sales Acting As A Drag

China – Real Estate-Related Retail Sales, % chg y-o-y And % Of Total

Source: Wind, Fitch Solutions

…Also Constraining Aggressive Infrastructure Stimulus

Given that the fiscal revenues of Chinese local governments are heavily reliant on the value of land sales, weakness in the property market would likely to constrain their ability to significantly boost infrastructure spending, without a corresponding increase in government debt, something Beijing is likely to avoid given its drive to rein in debt growth (see ‘Local Governments' Fiscal Revenues Facing Downside Risks’, November 1, 2016). The People’s Bank of China’s inclusion of special bonds issued by local governments for infrastructure spending in the calculation of total social financing, starting from the September release, showed Beijing’s commitment to increase oversight of local government finances. This is in line with the State Council’s decision in July to speed up the approval of the issuance of these bonds to quicken the implementation of infrastructure projects, rather than increasing the amount of issuances for the remainder of 2018.